The Bank of England’s road to a Bank Rate cut is paved with group think and a lack of diversity

The was indeed something in the air last night almost as if Steven Gerrard was in control of events and everybody had to listen to Phil Collins on repeat. It reinforced a theme of this blog which is the trend towards ever lower interest-rates and the arrival of negative interest-rates and yields. Benoit Coeure of the ECB gave an interview including this as he arrived in Sendai Japan for the G7 meeting.

It is in principle possible to cut this rate further, but there is currently no plan to do so.

There never is a plan to cut below the “lower bound” but that lower bound does keep getting lower. After all Monsieur Coeure is in the country where negative interest-rates arrived only 8 days after Bank of Japan Governor Kuroda denied any such plans. Still after flying from France to Japan presumably in at least business class we should be grateful perhaps he did not lecture us on the dangers of climate change.

The Bank of England

Bank of England policy maker Gertjan Vlieghe was much clearer about his intentions in a speech to the London Business School. firstly he confirmed that I have been anticipating his thoughts correctly.

Despite repeated forecasts of stabilisation, UK GDP growth has continued to slow, from around 3% in 2014, to around 2% in 2015, to less than 2% in 2016 so far…… Headline inflation is well below target at 0.3%……..Wage inflation at around 2% continues to be weak .

Accordingly we are well set up for this.

it adds up to a significant downward revision in growth and inflation, to which monetary policy has not responded so far.

Okay Jan how should monetary policy respond and the emphasis is mine?

Following a vote to remain, I would like to see convincing evidence of an improvement in the economic outlook, in line with the forecasts in the May Inflation Report. If such improvement is not apparent soon, this will reduce my confidence that inflation is likely to return to the target within an acceptable time horizon without additional monetary stimulus.

This immediately raises two thoughts. As the Bank of England regards us staying in the European Union as its central case then Jan is saying unless the UK economy improves he will cut Bank Rate and/or vote for more QE (Quantitative Easing). Also that the Brexit referendum is being seen as a convenient excuse for the Bank of England to drop its “all for one and one for all” promises of Bank Rate rises under the ill-fated Forward Guidance of Mark Carney.

Actually tucked away in the speech is quite a critique of the same Forward Guidance.

Instead, a significant downward move in the market path of interest rates over the past two years has provided the stimulus the economy needs to return inflation to the target over the forecast horizon.

If we skip back 2 years (actually 23 months) via the TARDIS of Dr.Who we would be able to hear Bank of England Governor Mark Carney’s Forward Guidance.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect.

No it didn’t Mark! Even worse people and businesses who took out fixed-rate deals for mortgages and business loans have lost out. Indeed if anything this broad hint of a Bank Rate rise looks even further away than ever. Jan is probably safe from the Governor’s famous temper though as he is busy in Sendai Japan as presumably his published concerns about climate change do not apply to his own globe-trotting by aeroplane. There is a darker view which is that Jan is provided an excuse for yet another Carney U-Turn.

What about after a possible Brexit?

Jan has a view on this too.

If the vote is to leave, the MPC will be faced with an entirely different set of policy challenges. Given significant uncertainty about the future of the UK’s trading relationships, a meaningful drop in domestic demand and in the exchange rate is possible………… The UK is therefore likely to experience lower growth, and higher inflation for a period as a weaker exchange rate pushes up import prices.

It does not take too long to translate this. If we look back to 2011 we see the Bank of England looking through higher inflation ( CPI and RPI both rose above 5%) and concentrating on economic growth. So again we see that “additional monetary stimulus” seems set as the response to “lower growth” and a “meaningful drop in domestic demand”. In reality we know that this looking through of higher inflation weakened the economy via its impact on real wages of which more later but central bankers live in another world.

Long-Term Interest-Rates

This is an area in which I take quite an interest and some of the views expressed by Jan Vlieghe are rather extraordinary and other worldly. Let me illustrate.

Long-term interest rates play an important role in monetary policy. They are a key part of the transmission mechanism, via which monetary policy affects the wider economy

As they have fallen substantially then monetary policy has given the UK economy quite a boost. For example the 10 year Gilt yield which was 3.35% some 5 years ago is 1.46% as I type this. So if we have received a “key part” of monetary policy why are we near to needing another monetary stimulus Jan?

If we continue the Phil Collins theme then the Genesis of Jan Vlieghe’s ideas seem lost in a land of confusion. Let me start with something I agree with.

the most important factor behind the fall in long-term interest rates since the financial crisis has been a downward revision in the expected path of policy rates,

As I pointed out earlier the “lower bound” for interest-rates has got lower and lower but then Jan slips up.

with inflation expectations relatively stable,

Er no we had higher inflation expectations in the run-up to the 2011 inflationary episode and by UK standards they are very low now. Perhaps Jan thinks he has an escape clause with the word “relatively” after all they are relatively stable to my subject of yesterday Venezuela.

Also one has to speculate on what Jan was smoking before he wrote this bit.

nor is there any evidence that government bond yields are “distorted” by central banks’ asset purchases

After all the ECB can save 80 billon Euros a month is that is true and the Bank of Japan trillions of Yen. Oh and if we look at the Euro area then the “key transmission” of long-term interest-rate must have saved it surely if we look at how many bond yields are negative. But how did they get there as they have not been “distorted” by all the QE? And how did it happen at the same time?

My Rebuttal

I do not wish to only be critical of central bankers as it is easy to be pigeonholed so let me present another way. Regular readers will be aware that rather than aiming for higher inflation as Jan Vlieghe has done here I argue that lower inflation is a good thing as it boosts real wages. Yesterday’s UK Retail Sales numbers provided yet more evidence of that.

The volume of retail sales in April 2016 is estimated to have increased by 4.3% compared with April 2015.

Back in January 2015 I pointed out that I expected lower inflation to boost retail sales so how is that going?

Average store prices (including petrol stations) fell by 2.8% in April 2016 compared with April 2015.

So many economists claim higher inflation as an economic cure. Yet lower inflation has plainly boosted UK Retail Sales!

Comment

A criticism of the Bank of England these days is the lack of diversity on it. I do not mean in terms of sex bias although of course after appointing two female members that issue seems to have been put on the back burner as the fashion for it faded.  I mean that we have as the last two appointees to the Monetary Policy Committee a hedge fund manager ( Vlieghe) and an investment banker (Saunders). The clear and present danger which to my mind is being displayed is of what is called group think which is particularly poor when these two individuals are supposed to be external members. I have also pointed out before the danger of “Carney’s Cronies” being appointed. Nobody will question how we got to Forward Guidance Mark 19 in such an atmosphere.

Such a view needs confirmation from an official denial of it so here is Andy Haldane the Chief Economist.

The good news on this front is that, with the arrival of new staff with new and different skills at the Bank over the past few years, its personality has already become more diverse, perhaps significantly so.

So who argues that lower inflation is an economic benefit then?

Imputed Rent

There have been some developments on this issue this morning as the Office for National Statistics updates some datasets.

the improvement to imputed rental is one such change where, because the main impact is on the prices being used, the current price revisions are larger than the real GDP revisions.

I was ahead of the game and posted on the Royal Statistical Society website on how unsatisfactory all this is. Frankly it looks as if they do not know what they are doing…..

G7

Here are my thoughts from Share Radio earlier.

https://audioboom.com/boos/4590549-what-will-the-g7-conference-agenda-look-like-shaun-richards-looks-ahead-to-the-event